Excerpt: - .....share. 2. first above two items of shares were to be delivered in the middle of july, 1956. the shares contracted under the last item were to be delivered by the 23rd august, 1956. the shares under the first two items were delivered piece-meal and the total delivery was completed by the 11th july, 1956. these were billed at rs. 23.13. by the company's letter dated 20th august, 1956, addressed to the share-brokers, it was suggested that the amount paid in excess, viz., rs. 1,49,897, in respect of the first two contracts should be treated as advance payments towards the last contract and to this the broker agreed. at the same time, the assessee by its letter written on the same day pointed out that the delivery of the shares under the last mentioned contract would be taken not on 23rd.....

Judgment:

Sabyasachi Mukharji, J.

1. This is a reference under Section 66(1) of the Indian I.T. Act, 1922. The reference relates to the assessment years 1957-58 and 1958-59 the relevant accounting years being the English calendar years 1956 and 1957, respectively. The assessee is a public limited company. The assessee was dealing exclusively in shares of joint stock companies. For the said purpose, the assessee had entered into certain contracts with the well-known firm of share brokers, viz., M/s. Sohanlal Pachesia. During the material period, the assessee had purchased the following shares of Rohtas Industries Ltd., under three separate contracts:

2. First above two items of shares were to be delivered in the middle of July, 1956. The shares contracted under the last item were to be delivered by the 23rd August, 1956. The shares under the first two items were delivered piece-meal and the total delivery was completed by the 11th July, 1956. These were billed at Rs. 23.13. By the company's letter dated 20th August, 1956, addressed to the share-brokers, it was suggested that the amount paid in excess, viz., Rs. 1,49,897, in respect of the first two contracts should be treated as advance payments towards the last contract and to this the broker agreed. At the same time, the assessee by its letter written on the same day pointed out that the delivery of the shares under the last mentioned contract would be taken not on 23rd August, 1956, as originally agreed to, but within the period of 9 months, that is to say, before 23rd May, 1957, and the assessee agreed to pay interest at Rs. 6% per annum on value of the shares from the 23rd August, 1956, to 23rd May, 1957. The reason for postponing the delivery was, it was stated, lack of funds. The interest was calculated at Rs. 51,435 in the assessment year 1957-58 and Rs. 54,575 in the assessment year 1958-59. The assessee claimed the aforesaid amounts as deduction in the respective income-tax assessments. The claim was disallowed by the ITO in 1957-58 for the following grounds, (i) that there was no resolution of the board of directors for payment of interest; (ii) that the value of the shares under contract, that is, the last mentioned contract, were adjusted in the books of accounts; and (iii) that the shares were not shown as the stock-in-trade and as such the payments of interest did not relate to any item of asset or liability of the relevant previous year for that assessment year; and (iv) there was no loan in existence in the relevant previous year which could be said to have been taken for the purpose of purchase of the shares. For similar reasons the ITO disallowed the assessee's claim for interest for the assessment year 1958-59. There was an appeal before the AAC. The AAC held that the ITO was justified in disallowing the claim on account of interest in both these years. The AAC further held that the interest paid was mainly an amount paid in advance by way of inducement to the broker for acquiring the shares in question but not interest paid on money borrowed. In his order relating to the assessment year 1958-59, the AAC, however, observed that the payment of both the amounts of interest constituted part of the purchase price of the shares but since the assessee-company's claim for loss resulting from valuation of the shares held as closing stock at the ruling market rate had been disallowed in these assessments, the finding that the amounts of interest constituted the cost of the shares to the company would not in any way affect the resulting profit disclosed in the share accounts of the company and, therefore, would have no effect so far as the computation of the company's assessable profits or gains are concerned.

3. There was a further appeal by the assessee-company to the Tribunal. It was contended before the Tribunal on behalf of the assessee-company that it was incorrect to state that there was no resolution passed by the board of directors authorising the payment of interest in question and to insist that the value of the shares proposed to be purchased should have been adjusted in the books of account and shown as part of stock-in-trade. It was further argued on behalf of the assessee that the nature of the transaction was not properly appreciated. It was urged on behalf of the assessee-company that the company had no available funds to take delivery of the shares on the stipulated date that it had agreed to pay the interest in question to the firm of share brokers as an inducement because the rate of purchase mentioned in the contract was found to be advantageous in view of the rising market and the fulfilment of the contract on a deferred date, even at the cost of paying the interest in question, was found profitable by the company. In the premises, it was urged that the payment of interest was definitely for the purpose of the company's business. On behalf of the revenue, it was argued that the arrangement for deferred delivery did not relate to the creation of any debt in favour of the share-brokers and, therefore, payment of interest did not constitute an expenditure laid out wholly and exclusively for the purpose of the company's business. The Tribunal rejected the revenue's point of view on the ground that the shares in question were stock-in-trade of the assessee-company and it was an arrangement with the share-brokers by which the company was assured of its supply of the stock-in-trade at an advantageous price. The Tribunal further accepted the plea of the assessee-company that but for the arrangements for deferred payment the assessee-company would have been saddled with claim for damages for non-fulfilment of the contract. The Tribunal found that in a rising market the assessee-company would have otherwise lost a good slice of its profit. The Tribunal also found that the adjustment of the value of the shares in its books as purchased and showing the same as closing stock would not have been justified by the facts of the case because, according to the Tribunal, title to these shares had not passed from the brokers to the company during the relevant accounting period'. The board of directors of the assessee-company had passed the necessary resolution on 18th May, 1957, ratifying the arrangements made between the assessee-company and the share-brokers. The Tribunal, therefore, came to the conclusion that the payments claimed to have been made to the brokers represented expenditure incurred for the purpose of the business and should be viewed in the larger context of business necessity. The Tribunal, therefore, allowed the assessee's claim. On an application being made under Section 66(1) of the Indian I.T. Act, 1922, the following question has been referred to this court :

'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sums of Rs. 51,435 and Rs. 54,575 which were payable in respect of the previous years to the assessment years 1957-58 and 1958-59, respectively, as interest by the assessee-company to the share-brokers were allowable as revenue expenditure against the business income earned by the company during those years ?'

4. We have mentioned hereinbefore the findings of the Tribunal. It was clearly found by the Tribunal, and in our opinion rightly, that the shares in question were the stock-in-trade of the company. It is to be noted also that under the arrangement the company, by which the liability for payment of interest had been incurred, had ensured supply of the stock-in-trade at advantageous prices. The Tribunal has also noted, if the company had not taken the delivery of the shares on the stipulated date, that would have given rise to the cancellation of the contract for sale of the shares by the broker and a claim for damages would have arisen. It appears, therefore, that in order to keep alive the contract which ensured the supply of the stock-in-trade, these payments had been incurred. Whether a particular expenditure is a revenue expenditure or a capital expenditure has to be determined by the application of well-known principles. While the principles are clear, their application to the particular facts of the case often present certain difficulties. In a given case of this type, one has to bear in mind the demarcation whether the payment was incurred in order to ensure the source of stock-in-trade or to obtain the stock-in-trade themselves. If the payment was to ensure the source of stock-in-trade then the expenditure incurred for that purpose would be capital expenditure. If, on the other hand, payments are made to obtain stock-in-trade under a source arranged for, then such payments would be payments for the supply of stock-in-trade and for carrying on the business. In the case of Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT : [1965]56ITR52(SC) the Supreme Court observed as follows (headnote):

'In considering whether expenditure is revenue expenditure, the court has to consider the nature and the ordinary course of business and the objects for which the expenditure is incurred. The question whether a particular expenditure is revenue expenditure incurred for the purpose of the business must be viewed in the larger context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying of the business, the expenditure may be regarded as revenue expenditure.'

5. There is no doubt, in the instant case, that the expenditure was related to or connected with the conduct of the business. But the only question that falls for consideration in this case is, whether the expenditure was for acquiring the right or an asset of a permanent character. Whether an expenditure of this nature resulted in the acquisition of an asset of a permanent character has to be viewed in the light of the principles well enunciated. In the case of John Smith and San v. Moore (H. M. Inspector of Taxes) [1921] 12 TC 266; [1921] 2 AC 13f the sole proprietor of a coal merchant's business died on the 7th March, 1915, and under the terms of his trust, disposition and settlement his son took over the business at a valuation, in which nothing was charged for goodwill. The price paid included a sum of 30,000, representing the value of certain unexpired contracts with colliery owners for the supply of coal at fixed prices, all of which contracts expired on or before the 31st December, 1951, and the question was whether the payment of 30,000 made in respect of unexpired coal contract was an admissible deduction in computing the profits of the business for the purpose of Excess Profits. Duty for the accounting period from 7th March, 1915, to the 31st December, 1915. It was held by a majority judgment that the sum of 30,000 paid in respect of the unexpired coal contracts was not an admissible deduction in computing the profits of the business for the purposes of Excess Profits Duty for the accounting period from 7th March, 1915, to the 31st December, 1915. Viscount Haldane and Lord Sumner proceeded on the basis that the expenditure was a capital expenditure while Viscount Cave proceeded on the ground that the Excess Profits Duty was a tax on a continuing business, and that for the purposes of the question at issue the change of ownership should be disregarded. At page 282 of the report, Viscount Haldane observed as follows :

'My Lords, profit may be produced in two ways. It may result from purchases on income account, the cost of which is debited to that account, and the prices realised therefrom are credited, or it may result from realisation at a profit of assets forming part of the concern. In such a case a prudent man of business will no doubt debit to profit and loss the value of capital assets realised, and take credit only for the balance. But what was the nature of what the appellant here had to deal with He had bought as part of the capital of the business his father's contracts. These enabled him to purchase coal from the colliery owners at what we were told was a very advantageous price, about fourteen shillings per ton. He was able to buy at this price because the right to do so was part of the assets of the business. Was it circulating capital ?

My Lords, it is not necessary to draw an exact line of demarcation between fixed and circulating capital. Since Adam Smith drew the distingtion in the Second Book of his Wealth of Nations, which appears in the chapter on the Division of Stock, a distinction which has since become classical, economists have never been able to define much more precisely what the line of demarcation is. Adam Smith described fixed capital as what the owner turns to profit by keepting it in his own possession, circulating capital as what he makes profit of by parting with it and letting it change masters. The latter capital circulates in this sense.

My Lords, in the case before us the appellant, of course, made profit with circulating capital by buying coal under the contracts he had acquired from his father's estate at the stipulated price of fourteen shillings and reselling it for more, but he was able to do this simply because he had acquired, among other assets of his business, including the goodwill, the contracts in question. It was not by selling these contracts, of limited duration though they were, it was not by parting with them to other masters, but by retaining them, that he was able to employ his circulating capital in buying under them, I am accordingly of opinion that, although they may have been of short duration, they were none the less part of his fixed capital. That he had paid a price for them makes no difference. Indeed the description of their value by the accountants, in the words I have earlier referred to, as of doubtful validity in the hands of outsiders, emphasises this conclusion. The 30,000 paid for the contracts, or its equivalent, therefore, became part of the appellant's fixed capital and could not properly appear in his revenue account. If that be so, then it was a sum employed as capital in his trade, and has to be excluded as a deduction from the profits on which he is assessed.'

'Is this a case of a purchase of the raw material of the trade, i.e., the stock-in-trade in, which a particular trader deals, or is it a case of a purchase of a capital asset from which the taxpayers will be able to derive raw material or stock-in-trade as and when the requirements of the taxpayers' business make it expedient to do so ?'

7. Reference in this connection may also be made to the observations of Lord Greene M.R. in the case of Henriksen (H. M. Inspector of Taxes) v. Grafton Hotel Ltd. [1942] 24 TC 453; [1943] 11 ITR (Suppl.) 10.

8. The true test, therefore, is whether by the payment in question, with which we are concerned in the instant reference, the assessee was purchasing the raw materials or the stock-in-trade, namely, the shares or whether the assessee was ensuring a source from which he could derive raw materials or stock-in-trade. It is true that by keeping the contract alive the assessee had deferred the supply of the stock-in-trade in order to be able to mobilise the funds in which the assessee was admittedly lacking. But by the contract the assessee was getting the supply itself. It was not a case of a contract which ensured supplies at a future time. It was a case of a contract under which the assessee acquired the very stock-in-trade. In order to keep alive that contract, which the assessee had entered into previously when the prices were low, the assessee agreed to pay the interest for its failure to pay the price in time. That in our opinion is not ensuring or acquisition of a capital asset from which the assessee could obtain the stock-in-trade but rather it was a case of purchase of the raw materials at enhanced prices in the shape of interest for delayed payment. If that is the position and if the transaction was related to the carrying on of the business, about which there cannot be any doubt in this case, then, viewed in the light of the facts and circumstances of the case, the company had only entered into this arrangement for additional payment of interest for the purpose of obtaining the stock-in-trade. It must, therefore, be held that the expenditure incurred must be for the purpose of business. This was, therefore, an expenditure which related to the profit-earning process. By this contract, the assessee-company did not acquire any asset of any permanent character which ensured to the assessee supply of any future stock-in-trade or shares. In that view of the matter, we are of the opinion that the Tribunal was right in coming to the conclusion that the expenditure in question was incurred for the purpose of the trade or for the carrying on of its business activities and the expenditure was, therefore, allowable as revenue expenditure. In the premises, the question referred must be answered in the affirmative and in favour of the assessee.

9. Before we conclude we must observe that our attention was drawn to certain observations of a Division Bench of this court in the case of CIT v. Bibhuti Bhusan Dutt [1963] 48 ITR 233. In the view we have taken it is not necessary for us to discuss the said observations in the said case.

10. The question is answered in the affirmative and in favour of the assessee. There will be no order as to costs.